Asia-Pacific economies face sizable external pressure, notably from uncertain U.S. tariff policy and soft imports in China. We expect domestic demand to broadly remain healthy, in part because of policy easing. But what this means for the resilience of regional economies varies sharply, with export-dependent ones less well placed.

Global Setting: U.S. Policy Changes Weigh On Global Outlook

The new U.S. administration  is changing economic policy. It aims to tighten immigration and deregulate sectors such as energy and finance. On the fiscal front, it plans to cut taxes and government spending, with an uncertain impact on the budget deficit.

We expect the increase in U.S. import tariffs  and the uncertainty about them to harm trade, investment and growth globally. The U.S. in April suspended its country-specific "reciprocal" tariffs soon after introducing them. In May it reached an agreement with China to lower bilateral tariffs that had escalated to more than 100%. In early June the two countries withdrew some restrictions that both sides previously rolled out amid a flareup of bilateral tensions.

We nevertheless expect country-specific U.S. tariffs and the uncertainty about them to end up substantially higher than before January. Moreover, following 25% sectoral tariffs on cars and car parts, steel and aluminum in early June, the U.S. raised tariffs on steel and aluminum to 50%. The U.S. also intends to impose tariffs on semiconductors and pharmaceuticals, and risks around tariffs are high.

Tariffs are likely to raise inflation in the U.S, complicating the outlook for monetary policy. We now project the Federal Reserve to cut its policy rate by 50 basis points late this year in the wake of a likely economic slowdown, with more cuts in 2026.

Plans for major increases in European spending on defense and infrastructure (in Germany) should support growth there from 2026 onwards.

Risks to the global economy have risen due to the turbulence in the Middle East. Long-lasting major increases in oil prices could have significant economic impact in Asia-Pacific, notably via slower global growth and pressure on the current accounts of net energy importers, prices and costs. However, current conditions on global energy markets--which are well-supplied-- make such long-term impact on oil prices unlikely.

China's Growth Should Remain Significant Despite U.S. Tariffs

The resilience of economic growth in much of the first half of 2025 was helped by robust exports, partly due to a temporary frontloading of shipments to the U.S.

Chart 1

Chart 2

Domestically, although housing sales are close to stabilizing, housing construction continues to slide (see chart 1). That construction weakness weighs on investment even as consumption growth improves steadily (see chart 2).

The sharp reduction of bilateral tariffs  between the U.S. and China in early May was a relief for exporters and the economy. After a major downward revision of our China growth outlook in April in the wake of the escalation of bilateral tariffs, the de-escalation has brought the growth outlook back close to the one we had in March (see "Economic Outlook Asia-Pacific Q2 2025: U.S. Tariffs Will Squeeze, Not Choke, Growth," March 26, 2025).

However, the rise in U.S. tariffs on China (and uncertainty about them) will weigh on exports, investment and growth. Without progress in bilateral negotiations, tariffs will likely rise again. Given the U.S.-China tensions on various fronts, renewed escalation remains possible.

While the outlook for China's exports to the U.S. worsens, we expect slowing world trade and, possibly, trade restrictions by other countries to weigh on China's shipments to these other destinations. In all, we see exports slowing materially in the second half of the year.

Domestic demand growth will likely be more resilient than exports. Policymakers have vowed to take measures to boost domestic demand. Actual measures toward this goal have so far have remained modest, as the economy has held up. Assuming macro policy support remains data-dependent, domestic demand growth will likely hold up this year and next.

In all, we now expect 4.3% GDP growth in China in 2025 and 4.0% in 2026. While this is significantly lower than the government's target for this year, it would be a solid result given the external strains. Chinese imports will be subdued this year and next, but not as weak as exports.

We expect consumer price index (CPI) inflation and the change in the GDP deflator to remain very subdued in 2025 and 2026. That is amid excess capacity in many sectors and additional downward pressure on prices from the redirection of sales in the face of U.S. tariffs.

Resilient Domestic Demand Limits The Slowdown in Asia-Pacific

Many regional economies had a good start to 2025 on robust domestic demand. Several got a temporary fillip from a frontloading of exports to the U.S. ahead of anticipated tariffs (see charts 3 and 4). In India, growth picked up after a soft patch.

There were exceptions. Notably, following several weak quarters, South Korea's GDP shrank sequentially in the first quarter to a level lower than a year ago amid struggling domestic demand and political uncertainty.

Japan's economy also contracted somewhat on that basis, and Australia's growth remained low. Higher uncertainty, subdued income growth and elevated cost of living pressures have dampened domestic demand in these countries.

The suspension of high U.S. country-specific reciprocal tariffs and a U.S.-China detente have provided relief. As was the case for China, the easing of the U.S. stance has brought our growth projections for 2025 and 2026 mostly back close to our March outlook, after earlier downward revisions.

Still, the prospect of significantly higher U.S. tariffs than before January will likely weigh on Asia-Pacific growth. Increased uncertainty about tariffs is also a negative. Moreover, several Asian economies will be exposed to the sector-specific tariffs the U.S. government said it will impose on pharmaceutical products and semiconductors.

Meanwhile, attempts to redirect Chinese shipments away from the U.S. will likely challenge sectors and companies in the region.

Chart 3

Chart 4

Solid domestic demand and stable macroeconomic fundamentals should contain the slowdown in 2025 and 2026. The absence of inflationary pressure and major external deficits provides a buffer in case policymakers want to ease macroeconomic policy to support growth.

Domestic demand resilience is particularly relevant in limiting the economic slowdown in economies less exposed to goods exports such as India and the Philippines (see chart 5). Indeed, we see India's GDP growth holding up at 6.5% in fiscal 2026 (year ending March 31, 2026). That forecast assumes a normal monsoon, lower crude oil prices, income-tax concessions and monetary easing.

In more export-dependent economies such as Malaysia, Singapore, South Korea, Taiwan and Vietnam we expect a significant slowdown in 2025 (see chart 6).

From a medium-term perspective, supply-chain shifts have been modest so far. Constructive trade policies in most of Asia-Pacific should support growth and productivity. Still, higher uncertainty about external trade and investment conditions will weigh on the outlook.

Chart 5

Chart 6

Central Banks Have More Room To Cut Policy Rates

Inflation has generally receded even as sequential core inflation has risen in Indonesia, Malaysia and India in recent months.

Recent falls in global energy prices and currency appreciation against the U.S. dollar will dampen price increases in the months ahead, even taking into account the recent rise in the oil price amid Middle East turmoil.

In India, falling food inflation also helps contain headline inflation. Across the region, redirection of exports away from the U.S. will weigh on price increases.

Strengthening currencies against the U.S. dollar  mean that external factors are unlikely to significantly constrain policy rate cuts.

Interest rate differentials with the U.S. work against rate cuts in Asia-Pacific (interest rates in the region are low relative to the U.S.). This hasn't prevented Asia-Pacific currencies from appreciating against the U.S. dollar by an average of almost 5% so far this year.

Developed-market currencies have generally gained more (see charts 7a and 7b). The currency strength stems in part from the repricing of U.S. assets on financial markets.

Chart 7a

Chart 7b

A sudden appreciation of the New Taiwan dollar led to concerns in the market about foreign-exchange losses on balance sheets. In Hong Kong, strong foreign inflows led to large declines in local interest rates as the Hong Kong Monetary Authority intervened to prevent the local currency from strengthening.

We expect central banks in this setting to cut policy rates, particularly with policymakers highlighting growth risks. Most central banks have already cut policy rates this year, even as U.S. policy rates remain elevated.

This includes the Reserve Bank of Australia, which started cutting later due to more sticky inflation. The only exceptions are the central banks of Malaysia and Taiwan, where interest rates are already low. Further cuts across the region are likely in the coming 18 months (see chart 8).

Chart 8

We anticipate a gradual increase in Japan's policy rate in coming years. Wage growth has lagged headline inflation in 2025. This has weighed on household real disposable income and consumption. The Bank of Japan has also highlighted the risk to growth of external pressures.

Recent spikes in long-maturity government bond yields led the Bank of Japan to moderate its quantitative tightening program. Still, barring major global shocks, the continued rise in consumer inflation will prompt the central bank to resume policy rate increases, in our view.

Asia-Pacific economies face sizable external challenges, notably from uncertain U.S. tariff policy and soft imports in China. We expect domestic demand to remain relatively resilient. The extent to which that can limit a slowdown this year and next varies across the region, with the export-dependent economies less well-placed. In this setting, central banks are likely to continue to cut policy rates amid benign inflation and external conditions.

Appendix

Table 1

Table 2

Table 3

Table 4

Table 5

Related Research:

• Global Aging Trends Are Catching Up To Southeast Asia, June 11, 2025
• Economic Outlook Asia-Pacific Q2 2025: U.S. Tariffs Will Squeeze, Not Choke, Growth, March 26, 2025